Companies with less than $10 Million of annual EBITA are generally considered to be in lower-middle market business segment. These companies are typically privately-held and/or family owned. Prior to the most recent recession that began in 2007, the lower-middle market segment had been almost exclusively served by Banks, which hadn’t been met with any serious competition from non-bank lenders offering similar products and terms. As economic conditions have improved the needs of this market segment have shifted from traditional working capital and asset-based financing to expansion capital and business acquisition financing, placing a growing demand for lenders that understand and have products for these non-traditional credit needs.
There are two emerging trends in the lower-middle market business lending segment; first, this segment is finally realizing long-awaited opportunities to grow their businesses, and second, there are many baby-boomer entrepreneurs who are also focused on selling their businesses in the next 5-10 years, due to the rebound in business valuations with recent improvements to the economy and the market environment. Resulting in opportunities in both expansion and acquisition financing.
…the Small Business Administration (SBA) is appropriating another $1 Billion in annual funding for 2015, increasing the total SBA small business funding availability to $18.7 Billion.
The demand for expansion capital appears strong, as businesses get back to investing in infrastructure and expansion. Although, the increased demand does increase lending risk, with this economic cycle, the risk adjusted yields (ROI’s) are stronger than the incremental credit risks or loss-severity. Case and point, the Small Business Administration (SBA) is appropriating another $1 Billion in annual funding for 2015, increasing the total SBA small business funding availability to $18.7 Billion.
In addition to expansion capital demands, the opportunities for Exit Planning and M&A capital for the lower-middle market segment is robust. Traditionally, Banks would provide partial transaction funding by using a SBA or conventional loan in senior position with a smaller seller carry note in second position. In today’s market, additional, non-bank funding sources are playing a role in this capital segment; Private Equity groups (with lots of cash on the sidelines) and SBIC’s with significant funds available for small business investment in all areas of the capital stack.
While these trends seem to bode well for the banking industry and the business community, bank lenders serving the lower-middle market business segment need to reinvent their approach and stay in-front of the new opportunities with a well thought out strategy in mind. Good bank lenders will make sure they are adequately educated on the trends and not just reacting to the market, and chasing upward trends in credit risk and downward trends in yield as non-bank lenders compete for this business. It’s obviously good news that business owners are back for growth, acquisition and succession financing, however the banking industry needs to approach these opportunities prudently, with a disciplined approach to credit risk, market segment and concentration limits.
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